Photo by Resolution Property Investments

For many investors, building a HMO business is a gateway to doing bigger, more profitable and more exciting projects. If you’ve been following me on social media, you’ve probably seen the commercial to residential developments that I do outside of my interests in the HMO market. 

Read below or listen to the full episode on The HMO Podcast to learn about the main differences between HMOs and commercial to residential projects, the pros and cons involved in commercial to residential developments and why I wouldn’t recommend doing this without gaining experience in the HMO space first!

The cashflow, skills and confidence that I gained from my HMO business allowed me to start investing in commercial to residential developments. That foundation gave me the luxury to be able to go on and spend time and money doing these bigger projects.

The Key Differences

There are a few main differences between investing in HMOs and commercial to residential developments that are important to understand if you’re interested in doing bigger and more complex deals!

Capital

The amount of resource that you need to throw into commercial to residential deals at the front end is much greater than your average HMO. So, it’s a very capital-intensive model. You’ll need capital to purchase the building and convert it.

The development will typically be much bigger than it would be for just converting a house or small building into a HMO. Commercial to residential projects present the ability to create a lot of equity, but it’s a lot of wealth on paper. 

So, if you’re considering doing these types of deals, think about if you could afford to wait for up to two years to draw any cash from the projects, and keep in mind that you’re going to need a lot of cash and have a lot of bills to pay.

Once you’ve developed a commercial to residential project, you might have added a lot of equity to the building, but when you come to refinance it, that often gets swallowed up as your residual deposit.

So, there are not that many occasions where you’re crystallising huge sums of money even though you’ve gained it on paper, unless you want to dispose of the asset. But that in itself is an additional complication, especially when you look at how unstable the economy has been.

For me, I don’t want to develop anything that I’m not going to keep. Because of that, a lot of the equity ends up just getting tied back into the deal!

Cashflow

With commercial to residential developments, you’ll do a lot of work and have to wait a long time to get anything out of them. Even if you make a lot, it can take a long time for it to come out, so you have to be patient. Without an alternative recurring income stream in the background, it would be extremely difficult to do these sorts of projects.

Converting a standard property into a HMO is much more straightforward, and you can usually get the income stream switched on very quickly. But you just can’t do that with commercial to residential developments…

Because you’re putting so much more in at the front end and as these projects typically take a lot longer, your cash flow will be poor for some time. In our deals, it takes the best part of two years to buy, develop, refinance and get the cashflow coming through!

Additionally, if you want to do multiple deals at the same time, it really compounds the problem. So, with commercial to residential deals, you can develop cash-flowing assets at the back end, but as a model itself, it’s tough to create income quickly.

If you’re developing HMOs through this commercial to residential strategy, then that end product should still cashflow really well. But there are so few deals that would actually allow you to do that. There are some, but it will be tricky to find if you want to get the balance of finding the right properties and adding enough value.

On paper, we would get a far better return if we reinvested that money into HMOs. So, this is something to be aware of. This is why it’s ideal to already have a portfolio with an established income stream behind you.

Timelines

Commercial to residential developments are much more involved, and the timeline to crystallise profits is far greater. It depends on the size of the project, but commercial to residential projects often take between 12 to 24 months.

Part of that is in the build time and applying for and getting planning permission and building regulations, but these buildings can also take longer to buy as the lending and valuations are more complicated.

With commercial to residential developments, timelines are often dictated by the type of building, what you want to do with it and whether it needs planning permission. So, you really have to factor long timelines in.

Complexities

There’s a greater degree of complexity with commercial to residential projects than standard HMO projects. There are usually complexities with building control, planning permission and lending.

With commercial to residential projects, you ideally want to take advantage of permitted development rights. We’ll often buy projects that have a certain amount of permitted development rights that come with them, but that isn’t necessarily the way to fully optimise the scheme!

So, you may end up wanting to do work that needs planning permission. If you’ll need to apply for planning, it’s not as simple as just chucking an application in. You’ll have to give this a huge amount of thought as it’s a real art.

You’ll need to understand the policies and the frameworks both at the local and national level. And you often need to work with architects and planning consultants, and you may need various consultant reports.

On the other hand, with HMOs, it’s pretty straightforward. If there’s an Article 4 direction, you’ll need planning permission, which will either grant you the ability to convert something into a HMO or it won’t, making it pretty predictable.

You can also usually see lots of very similar examples of those kinds of HMO projects. But with commercial to residential developments, you won’t have the same degree of confidence because what you want to do each time will often be so different. So, there are things that you may not have examples of other people doing.

Additionally, when it comes to lending, you won’t be able to get development finance until you get planning. So, you might have to purchase the building with a bridge, private finance or your own finance. Once you’ve got planning permission, you can then apply for development finance. Then, when you finish the project, you’ll have to come off that and onto term finance.

Because of all the moving parts of commercial to residential projects, you’ve got to have the time, ability and desire to manage these complexities or manage a team of people who can help you with these areas!

Unpredictability & Risks  

There is also a greater degree of unpredictability when working on a commercial to residential project. This includes the build cost as the bigger the project the greater the degree of inaccuracy could be. All of a sudden, you could be out of your estimations by £100k, even though you’re still just 10% out. 

Overall, the risk is much higher for commercial to residential developments. There’s naturally so much more to think about and consider when it comes to converting larger buildings. Additionally, the bigger the project, the more challenging it usually is to value that project at the end compared to a standard HMO. 

With HMOs, you can see what other houses on the street look like and how much they’ve sold for. But if you’re converting a much larger building, that comparable evidence isn’t necessarily there.

The bank’s appetites are often quite different for these sorts of projects too. Sometimes they want you to leave more capital in these sorts of deals at the end because of the overall risk that they feel that the project may have on an ongoing basis. So, the unpredictability with the revaluation is definitely more of a feature here than it is with a standard HMO.

And if your best guess for the valuation is out by 5% to 15%, then at the end, you could be out by a huge number. There is also a greater risk of facing planning challenges and not achieving the results you wanted. And it could take up more of your money, time and energy. So, it’s really not for the faint hearted!

Finding Deals

Finding commercial to residential deals is more challenging than finding HMOs. A lot of HMOs are transacted on the open market and come onto platforms like Rightmove or Zoopla. Everybody can see them.

Commercial projects are not sold in the same way. Some come on with agents and end up on similar national portals like Rightmove Commercial. Some go to national auction houses, local auctioneers or commercial agencies, which operate very differently to residential agencies.

A lot of these deals move around in fairly discrete channels and are sold privately before they hit the open market. To find the best deals, you’ll need to cast a much wider net and be much more involved on the ground.

Advantages of Commercial to Residential Projects

So, why would you invest in commercial to residential projects? There are a number of advantages and opportunities when it comes to these types of investment and development!

Scale of Economies

In business, you should always be looking to leverage your skills, resources and network, and that scale of economy is doing more with commercial to residential projects because there’s an extra zero on the project value.

It means you can hopefully spend a similar amount of time to get better results. That’s aside from all the risks we talked about, but in its simplest form, that’s one of the key objectives. You can spend a similar 18 to 24 months, but on paper, you can create a lot more wealth because the numbers are much bigger!

Challenges & Excitement

I really enjoy the challenge and excitement of commercial to residential developments. If you enjoy being involved in property, the setting up of deals, creating incredible assets, converting old buildings that communities place value on and doing really special things with them, this may be for you!

Commercial to residential projects can give you more scope. They allow you to work on more complicated deals and do more impressive things. I find this kind of investment much more attractive than even new builds because we get to reinstate things the way that it was done previously. I really enjoy that.

Equity

While HMOs are great for cashflow, commercial to residential projects are much more focused on the creation of equity and genuinely adding large amounts of value. While the equity tends to get tied up at the back end as you come to refinance it, it’s wealth on paper.

This kind of equity is difficult to create purely through HMOs. Most of the HMOs I invest in get 15 to 20% return on capital employed. But with the commercial to residential projects, we’re far surpassing that. That allows my business partners and I to create big lumps of equity.

Effort

Finally, the consolidation of effort at the front and back end is another big advantage. If you have a number of rooms or flats in a single building, then your management is consolidated.

It’s one refinance potentially for several buildings or several properties within a building. You can have one point of contact for your maintenance. If you go and inspect it, it can all be done on the same day, in the same place.

Concluding Thoughts

This will hopefully help you make a more informed decision about whether or not doing commercial to residential projects is right for you! And if it is, when would be the right time for you to do it?

If this is an area you want to invest in, the pros do outweigh all the cons for me. The main thing here is the timing… I wouldn’t want to have done these projects without my HMO portfolio and other property businesses behind me. So, if you haven’t built that up yet, you may want to get that foundation setup with recurring income coming in first.

 

If you have any questions about commercial to residential projects or anything else, come ask them over in our free Facebook Group The HMO Community!

If you want to level up your HMO business, become a member of The HMO Roadmap, where you can access all the tools, resources and support you need to build a HMO portfolio that can give you the foundation to go on and do these commercial to residential projects!

About the Author:

Andy Graham is the founder and the lead trainer at The HMO Roadmap! He is also the co-founder of The HMO Mastermind. He writes as a regular columnist in different magazines about a variety of HMO topics and is the host of The HMO Podcast! Follow Andy on Instagram!